The government has decided not to seek certiorari in the Deloitte case, thus leaving the law in some disarray with respect to the assertion of work-product privilege for tax accrual workpapers. Taxpayers in the First Circuit and the Fifth Circuit will have difficulty asserting the privilege; taxpayers in the D.C. Circuit will be on solid ground. If the IRS contests an assertion of privilege by a taxpayer located in another circuit, the parties will be left to duke it out and try to persuade the court of the relative merits of the Textron and Deloitte approaches.

As noted in our previous post, a government certiorari petition in Deloitte would have had to walk a fine line to avoid contradicting what the government had told the Court only a few months ago in opposing certiorari in Textron. A concern about undermining his credibility with the Court could have played a role in the Solicitor General’s decision not to seek certiorari in Deloitte. More likely, however, the decision was driven by a judgment that, in view of the ongoing initiative to require taxpayers to report their uncertain tax positions on their tax returns, resolving the Deloitte/Textron issue in the discovery context was not sufficiently important to the government to warrant asking the Court to step in. As discussed in this Miller & Chevalier Tax Alert, the IRS has just released its final schedule for reporting UTPs, along with other related announcements. The UTP initiative may well generate its own set of privilege disputes that could implicate the principles of Textron and Deloitte in another context.

Confounding the expectations of this observer (and others), the government has allowed the deadline to pass without seeking rehearing of the Deloitte case in the D.C. Circuit. That development does not mean, however, that the government has decided to live with the Deloitte decision. To the contrary, the most likely explanation for the government’s inaction is that it plans to seek Supreme Court review and does not want to delay that process. A petition for certiorari is currently due on September 27. If the government files by that time, the Court will act on the petition in enough time for it to schedule oral argument in the spring and decide the case by June 2011 (assuming that the Court decides to grant certiorari). If the government had sought rehearing, it would have lost control of the schedule. Depending on how long the D.C. Circuit took to rule on the rehearing petition, it is possible that Supreme Court consideration then could have been pushed off until the 2011-12 Term.

So the government has until September 27 to figure out how to explain to the Court why the issue that it said was so unimportant last May in Textron suddenly requires Supreme Court intervention. As noted in our previous post, one thing that the government will likely argue is that Deloitte has created a circuit conflict that did not previously exist, because it is the first court of appeals decision to find work product protection for tax accrual workpapers prepared as a routine part of the audit process. In Textron, the government had argued that cases approving work product protection like United States v. Roxworthy, 457 F.3d 590 (6th Cir. 2006), and United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), did not actually conflict with Textron and El Paso because the tax documents in question were prepared in anticipation of litigation and not in the ordinary course of business for use by auditors. (A copy of the government’s brief in opposition to the certiorari petition in Textron is attached.)

The D.C. Circuit has now decided the Deloitte case that was previously discussed on this blog. (See D.C. Circuit Considers Work Product Issues in Deloitte for that discussion and links to the briefs in the case.) The decision addresses two basic issues, and on both scores it gives comfort to taxpayers who do not want to furnish the IRS with their counsel’s candid assessment of litigation prospects on potential tax disputes.

With respect to the mental impressions of taxpayer’s counsel embodied in documents that are acknowledged to be work product, the court held that a taxpayer does not waive the privilege by sharing the analysis with its auditors. The court explained that a company’s auditor is not its adversary, and that the company has a reasonable expectation that the auditor will preserve the confidentiality of that information. Deloitte now becomes the leading appellate decision on the waiver issue, reaching the same outcome as the since-vacated decision of the First Circuit panel in Textron.

With respect to the issue that the Supreme Court recently declined to review, the court held that the “Deloitte memo” did contain work product in the form of orally transmitted opinions of Dow’s counsel, even though the memo was prepared by accountants. The court distinguished the two decisions from other circuits that have taken a much dimmer view of work product protection for tax accrual workpapers or similar documents. The court distinguished the Fifth Circuit’s old decision in United States v. El Paso Co., 682 F.2d 530 (1982), because that circuit uses a more restrictive standard for the work product inquiry into whether the document was prepared “in anticipation of litigation” — the “primary purpose” test — rather than the “because of” test applied by most circuits. With respect to the Textron decision, which comes from a circuit that has nominally adopted the “because of” test, the court noted that Judge Torruella’s dissent from the en banc decision in Textron had questioned whether the majority had truly adhered to the First Circuit’s stated standard. And the court suggested that there could be some difference in the content of the documents that warranted the different results. (This Miller and Chevalier Tax Alert contains a fuller discussion of the D.C. Circuit’s opinion as well as some observations on how it might affect the IRS’s initiative in Announcement 2010-9 to require disclosure of uncertain tax positions.)

Despite the court’s efforts to avoid a direct rebuff to the First Circuit, the reasoning of Deloitte is difficult to square with the Textron decision. And there is now a clear conflict with the Fifth Circuit’s El Paso decision, both with respect to the result in the case of tax accrual workpapers and with respect to the more general issue of the proper standard for assessing whether a document is work product. Therefore, if presented with a petition for certiorari in Deloitte, the Supreme Court may be more inclined to step into the fray than it was in Textron.

Before considering Supreme Court review, the government is almost certain to seek rehearing en banc from the full D.C. Circuit. That approach proved successful in Textron after the First Circuit panel had initially ruled in favor of the taxpayer. In the likely event that the D.C. Circuit does not rehear the case, the government will have to decide whether to seek certiorari after telling the Supreme Court a few months ago in Textron that this issue did not warrant Supreme Court review. That decision may depend in part on tactical considerations, such as whether the government believes that the Deloitte case presents a favorable factual setting in which to determine the correct test for work product, as well as the relative importance that the Solicitor General attaches to the workpapers issue.

The D.C. Circuit’s opinion is linked below. A petition for rehearing is due Aug. 13.

The Supreme Court’s recent denial of certiorari left intact the First Circuit’s en banc decision in United States v. Textron, Inc., 577 F.3d 21 (1st Cir. 2009), holding that Textron’s tax accrual workpapers had not been created “in anticipation of litigation” and therefore were not entitled to work product protection. The Supreme Court’s decision, of course, does not make Textron the law of the land, but rather leaves considerable uncertainty over whether other circuits will follow the First Circuit’s lead or instead place greater weight on a company’s interest in protecting from the IRS the company’s lawyers’ assessments of the strength of its tax positions.

The next insight into these issues could come soon from the D.C. Circuit in United States v. Deloitte & Touche USA LLP, 623 F. Supp. 2d 39 (D.D.C. 2009), appeal pending, No. 09-5171 (argued Feb. 26, 2010). The dispute in Deloitte arises in a different context from Textron, but it touches on similar issues. In the course of tax litigation with a partnership owned by Dow Chemical, the government sought discovery from Deloitte of three documents that contained opinions of Dow lawyers concerning the merits of the tax issues. The government agrees that two of these documents (a tax opinion prepared by Dow’s outside counsel and a legal analysis prepared by Dow’s in-house counsel) are attorney work product, but it argues that Dow waived the work product protection when it disclosed the documents to Deloitte. The third document is an analysis prepared by Deloitte that contains opinions of Dow attorneys that had been conveyed orally to Deloitte. The government argues that this document, prepared by accountants, is not work product.

The district court denied the government’s motion to compel in a brief opinion. It ruled that the Deloitte memo was work product because it recorded the thoughts of Dow’s counsel concerning the prospects in litigation. And it ruled that Dow did not waive the privilege by sharing its legal analysis with its auditors. The government’s appeal potentially could lead the D.C. Circuit to address several recurring issues.

The threshold issue of whether the Deloitte memo is work product presents the Textron issue, and the D.C. Circuit thus could directly address whether it agrees with the First Circuit’s view on tax accrual workpapers. The government repeats its winning argument in Textron that work product protection does not attach to tax accrual workpapers or similar documents that are prepared for the business purpose of preparing accurate financial statements. Dow, which has intervened as the real party in interest to oppose the government’s document request aimed at Deloitte, argues that work product protection attaches because of the documents’ content — namely, lawyers’ opinions of the prospects of litigation.

Both parties, however, have advanced arguments for distinguishing Textron that could allow the D.C. Circuit to avoid directly addressing the Textron reasoning. Dow argues that, whatever merit the Textron analysis has in the summons context where the IRS is examining a return and seeking to identify issues, it has no merit in the discovery context where the government has identified the issue and is just looking to enhance its litigation prospects by peeking through a window into the other side’s thought processes. The government, for its part, argues that the work product claim fails at the outset because, in contrast to Textron, the information is contained in a document prepared by accountants.

These issues concerning the definition of work product apply only to the Deloitte memo. Because the government does not dispute that the other two documents contain work product, the D.C. Circuit can also be expected to address the important issue of whether work product protection is waived by disclosing the information to a company’s auditor. This issue was decided in favor of Textron in the original First Circuit panel decision, but that decision was vacated and became irrelevant once the en banc court determined that the tax accrual workpapers were not work product in the first place.

The appeal was argued on February 26 before a relatively conservative panel — Judges Sentelle, Brown, and Griffith. It will be interesting to see how deeply the D.C. Circuit decides to delve into these issues and how directly it decides to address the Textron decision.

[Disclosure: Miller & Chevalier filed amicus briefs on behalf of Financial Executives International in support of Textron’s claim of work product protection in both the First Circuit and the Supreme Court.]

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.